Mess up gilts – you mess with pensions

Ah gilts – my pension provider decided that as I was nearing retirement they’d put the majority of my fund into “safe” 15yr Gilts. I retired last August. Since then my DC fund has lost over 25% in value thanks to the fall in gilts.

— 💙 Living with Covid doesn’t mean ignoring it (@Davrobin) September 23, 2022

The idea that people are safer in Government Bonds (known as gilt-edged stocks) is well established. Gilts represent the “risk free rate of return” – until that is , you are invested in a “gilts fund”.

When the yield on gilts rises, the value of the gilts you own falls. Why would anyone want to buy your pieces of paper promising to pay a fixed rate of interest when they can get a better rate from putting the money in the bank?

Normally the impact of a change in the markets may alter the “yield” on a gilt a tiny amount. But not this morning.

This is how the FT reported market reaction to today’s mini-budget.

UK government bonds sold off sharply and the pound hit a new 37-year low against the dollar as investors worried that Kwasi Kwarteng’s tax cuts and energy subsidies would place Britain on an “unstable” fiscal trajectory. (my emphasis)

The 10-year gilt yield surged 0.27 percentage points on Friday to 3.77 per cent, bringing its rise for the week to more than half a percentage point. This week’s rise marks one of the biggest increases in long-term borrowing costs on record.

Sterling fell on Friday below $1.11 for the first time since 1985, while the FTSE 100 share index slid 2.4 per cent. Friday’s heavy selling in gilts and the pound came after Kwarteng, the chancellor, said the government would scrap the 45p top rate of income tax, replacing it with a 40p rate.

 

I found Chris Philp’s preemptive tweet rather funny

Great to see sterling strengthening on the back of the new UK Growth Plan https://t.co/Ec8tgXkgKd

— Chris Philp (@CPhilpOfficial) September 23, 2022

Until I found out that Chris Philp is part of the Treasury Team that put the mini-budget together.

Minutes after his tweet, sterling fell almost 2% to a 37-year low of $1.10 as the yield on ten-year government bonds rose from 3.5% to 3.75%

Ooh look, Chris.

The currency markets’ reaction to the “new UK Growth Plan” you so eagerly welcomed.

Any thoughts, given your earlier “confidence”…? pic.twitter.com/aa7hC9qfGr

— Chris Shaw (@The_ChrisShaw) September 23, 2022

The approach taken by the Chancellor and his colleagues  reminds me of the English Cricket team this summer. The only difference is that the English Cricket Team were winners.

So what does it mean for your pension?

Well if you are in a pension where someone else takes the risk, you are in clover, the cost of funding your liabilities has gone down and your security of getting your pension paid has gone up.

The not quite such good news for DB schemes that have followed TPR’s advice and de-risked – using Liability Driven Investment is that some of the derivatives will now be so underwater that they’ll need cash to meet margins. Keating and Clacher estimate these calls to be c£60bn – which may mean some schemes having to force-sell assets.

Open pension schemes like LGPS, USS and Railpen will be benefiting from immunity to such cash-calls.

But if you are – like @davrobin above – finding yourself owning a load of gilts because your pension scheme thought that you’d be well protected in a risk-free asset – you will be nominally 30% poorer than this time last year.

A quarter of a point rise in gilt yields equals a 5% fall in the value of the gilts you hold.

a world of gain for pension schemes and a world of pain for those life styled into gilts

But heh! – that’s ok! – because you’re about to buy an annuity!

Annuity rates were approx 5.2%* at the beginning of the year. They are now at 6.5%.

We could see rates in excess of 7% by the end of the year.

*based on a 65 yr old, single life, level payments.

— Mark Ormston (@mdmormston) September 23, 2022

which is about 30% cheaper to buy than this time last year . You are just like all the pension schemes that have gorged on liability driven investments – rather poor – but super solvent.

Except , there’s this snag. You probably decided that when the Chancellor in 2014 said “nobody would have to buy an annuity again”  , you’d never buy an annuity – ever.

And rather than congratulating yourself on hedging your annuity purchase, you are cursing the day your pension trustees put you in a lifestyle programme and into a 15 year gilt fund. Happy days eh @davrobin.

One of my friends, who has been active in the fixed interest markets for five decades phoned me to tell me that this was the most stupid budget he had experienced in those 50 years. But then he is a socialist.

Worth repeating. Take all the tax changes coming in over next few years and:

If your income is < £155k, you lose

If your income is > £155k you win

If your income > £1m you gain more than £40,000 https://t.co/TkkGIKvNrl

— Paul Johnson (@PJTheEconomist) September 23, 2022

Government borrowing costs, which were supposed to fall with inflation which is being bought down with Government debt, is now through the roof. And it’s not just the Government

Following the chancellor’s announcement, markets were pricing in 0.75 percentage point rises at each of the next three BoE meetings, taking rates to 4.5 per cent by Christmas.

So what has Trussnomics done for your pension?

1. If you’ve been life styled , your pension could be  30% poorer for being in gilts
2. If you’ve recently bought an annuity, you got your timing wrong – (unless you are on a fixed term – in which case look at your options)
3. If you are invested in the UK; then don’t sell up and go abroad – you can’t afford it anymore
4. If you are invested abroad and your fund manager has hedged your currency exposure – you are in deep doo doo
5. If you are invested abroad and your fund manager hasn’t hedged you – you’re ok
6. If you are a saver and paying tax at 45% , invest this financial year to max your tax breaks by topping your pot up.
7. If on the other hand, your getting pension credit, your pension savings have just reduced your benefits.
8. The surge in salary sacrifice/exchange may lose some momentum as the November increases in national insurance are dropped.
9. Cuts in the additional rate on dividends and in corporation tax may make pensions less attractive tax shelters for small business owners
10. Meanwhile, in a small sop to basic rate taxpayers, the drop in tax relief to 19 per cent on pension contributions will not apply until April 2024.
11. The removal of performance fees from the workplace pension charge cap won’t make the slightest difference to asset allocation or pricing of such funds.
12. The rise in the gilt yield will bring the DB transfer market to a halt.
13. And an announcement that the government will replace Solvency II regulations with “rules tailor-made for the UK”  is likely to make annuities and bulk-buy out more affordable still
14. The absence of any coherent statements on environmental issues suggests the emphasis for new investment will be on growth not sustainability.

And for all those who think their pension is their property, ask yourself just who will be able to afford the mortgage to buy it.

Biggest tax cut in 50 years.
Largest one-day spike in gilt yields in 30 years
Lowest £/$ exchange rate in 37 years
Lowest consumer confidence since records began

How’s your Friday going?

— Alistair McQueen (@HelloMcQueen) September 23, 2022